Greetings. Welcome to Helios Technologies Third Quarter 2019 Financial Results Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note that this conference is being recorded. I'll now turn the conference over to your host, Karen Howard from Investor Relations of Helios Technologies. You may begin.

Thank you, Todd, and good morning, everyone. Welcome to the Helios Technologies third quarter and year-to-date 2019 financial results conference call. On the line with me are Wolfgang Dangel, our President and Chief Executive Officer; and Tricia Fulton, our Chief Financial Officer. Wolfgang and Tricia will be reviewing the results that were published in the press release distributed after yesterday's market close. If you do not have that release, it's available on our Web site at www.heliostechnologies.com. You will also find slides there that will accompany our discussions today. If you look through the slide deck on slide two, you will find our Safe Harbor statement. As you may be aware, we will make some forward-looking statements during this presentation and also during the Q&A. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from where we are today. These risks and uncertainties and other factors are provided in the earnings release as well as in other documents filed by the company with the Securities and Exchange Commission. These documents can be found on our Web site or at www.sec.gov. I also want to point out that during today's call, we will discuss some non-GAAP financial measures, which we believe are useful in evaluating our performance. You should not consider the presentation of this additional information an isolation or as a substitute for results prepared in accordance with GAAP. We have provided reconciliations of comparable GAAP to non-GAAP measures in the tables that accompany today's earnings release as well as in the slide. Wolfgang will get started with summarizing the third quarter of 2019. Tricia will go through the details of our financial results for the quarter and year-to-date period, and then we'll turn it back to Wolfgang for his perspective on our outlook in 2019 guidance, before we open up the lines for questions-and-answers. With that, it's now my pleasure to introduce, Wolfgang.

Thank you, Karen. Good morning, everyone. I will start on slide three. We reported sales of $138 million, a 2% increase over last year's third quarter. Our Hydraulic segment was the primary driver of the growth. Organic sales of our two segments, excluding currency grew 1% this quarter. Organic sales of our Hydraulic segment grew 4%, while sales in our Electronic segment contracted by 11%, both excluding the effect of changes in foreign exchange rate. As expected, currency had an unfavorable impact during the quarter. Despite the macroeconomic backdrop, overall, we are pleased with the consolidated revenue and the quality of earnings generated this quarter. Tricia, will provide more details on each segment's performance. Turning to the bottom line, we reported $12.8 million of net income, a 10% increase over the prior year. On a non-GAAP cash net income basis, debt represents $90.5 million or $0.61 per share. Adjusted EBITDA was $32.6 million or 23.6% of sale. Referring to the balance sheet and our leverage, we are very pleased with our cash generation this quarter. We realized free cash flow in excess of 15% of sales for the quarter, bringing us up to 10% for the year-to-date period on an adjusted basis, which is our target level. During the quarter, we also reduced debt by nearly $27 million. We closed the quarter with a 2.3 times net debt to adjusted EBITDA ratio, and we continue to work towards our goal of less than two times, which we anticipate achieving in mid-2020. Please turn to slide four, and I will provide a business summary for the third quarter of 2019. Our Hydraulic segment benefited from a solid backlog going into the quarter driving organic growth. However, our orders certainly felt the impact of weakening markets around the globe. In China, specifically,…

Thank you, Wolfgang, and good morning everyone. Let's begin on slide six, with a review of our third quarter consolidated results. Sales were up 2.2 million or 2% compared with last year's quarter. Our Hydraulics segment drove that growth. Acquisition revenue was $3.9 million representing CFP July revenue only, since the acquisition anniversaried on August 1. Our organic business sales grew 1% excluding the impact of changes in currency rate. Currency more than offset the growth with the 2.5 million unfavorable impacts. I'll now touch on sales by region, which are designated here in the sales bar charts on the left. During the 2018 third quarter, APAC realized year-over-year growth of 12%, while Americas grew 2% and the EMEA market declined by 9%. Sales to the Americas, EMEA, and APAC region were 49% 25% and 26% of the consolidated total respectively, in the third quarter. Regarding profitability, our consolidated adjusted EBITDA margin declined 120 basis points, but remained strong at 23.6%. Turning to the bottom line, non-GAAP cash earnings per share were $0.61, down $0.01 compared with last year's third quarter. The adjustments to arrive at non-GAAP cash earnings consist of acquisition related amortization of intangible assets, one-time restructuring costs and an intangible asset disposal. Last year's quarter also included acquisition related amortization of intangible assets and amortization of acquisition-related inventory step-up. These items are reflected in the reconciliation tables in the back of the slide deck and release. Please turn to slide seven for a review of our Hydraulic segment third quarter operating results. Consistent with prior periods, I want to point out that acquisition-related costs, including amortization, are not included in our operating segment numbers, they are accumulated in our Corporate and other segment reported in the tables at the back of our earnings release and slides. Sales…

Thanks, Tricia. Please turn to slide 14. Several of the macroeconomic factors that impact our outlook have weakened over the past quarter. Most notably, this pertained to the US-China trade war, the future of Brexit, and growing anxiety in the Middle East. We believe that uncertainty is slowing economic activity, which is affecting most of our end markets and geographies to varying degrees. Most of our end-markets including recreational and material handling, European agricultural, and oil and gas in the Americas have further softened. As noted last quarter, the construction equipment market in East Asia continues to weaken as well. Leading US indicators suggest that we are in a slowing growth phase, but the good news is that economic sources that we track continue to predict a soft landing. Around the world, nearly all major global economies are already experiencing either a slowdown of growth or negative growth. Specifically, Western Europe is in a mild recession and economic growth in China has decelerated. Again, the good news is that similar to the US, all global economies are currently expected to recover in the second-half of 2020. In accordance with our Vision 2025 plan, we expect to outpace macroeconomic growth over the long term. This is being driven by the investments we have been making to expand our coverage in the field, increasing and broadening relationships with OEMs, penetrating regions where we have white space, and continuing to introduce new and innovative products and solutions. Further, the actions we have taken to broaden from our traditional end markets into more diversified end markets expand our ability to successfully weather economic cycle. Please turn to slide 15 for our thoughts regarding our outlook for Helios for the remainder of 2019. In the overall macroeconomic environment, oil and gas, agriculture, recreational, construction in…

Thank you. At this time, we will conduct a question-and-answer session. [Operator Instructions] The first question is from the line of Nathan Jones from Stifel. Please go ahead.

Good morning, everyone.

Good morning, Nathan.

Good morning, Nathan.

Good morning, everyone. I'd like to start in Hydraulics, there's a few moving pieces here. I think you're probably shipping some past due backlog in Americas that probably contributed to the organic revenue there being up 13%. You talked about some capacity constraints in some products, which probably was a headwind to revenues there. Maybe you could just give us a little more color on, kind of, the impact of those different puts and takes on revenue during the quarter, and how do you stay that progressing going forward?

Sure, Nathan. Yes, it's exactly as you say, there is a couple of moving pieces. First of all, I mean, we still have quite some elevated backlog, and we pointed it out during earlier calls, Q1 and Q2 already. So, without any question, hydraulic sales in the third quarter was strong, because we could obviously tap into that backlog. However, that backlog is now depleting, and that obviously has an impact on the adjustments that we are making for guidance. With regard to the capacity constraints as I pointed out on numerous occasions, so we still want to ramp-up the capacity in order to be already prepared for the upswing in future, and we kind of consistently stick to that strategy, but we have idle capacity in the larger volume type of product families, and there is some fixed cost that we cannot cover right now. And by the way, that makes full sense, because this is mainly tied to OEM businesses, and as soon as the OEM market is softening, you see basically orders tapering down there, but you're quite right, I mean, revenue came in stronger in Q2 than we actually expected and the backlog helped us tremendously there.

So I mean, how many more quarters, do you think you're going to get a tailwind from the working off of this backlog going forward? Is it -- do you get some more help in 4Q, but it's gone by the end of the year, does it last into the first-half of next year?

Yes, well, we are definitely going to see some tailwind also in Q4, but that of course strongly depends on the orders that we are going to -- if the orders are further softening, obviously we have to dig deeper into the backlog. Based on the current assumptions, I think, we'll see a tailwind with regard to the backlog in Q4 and partly in Q1, 2020 as well.

Given that, I mean, Parker Hannifin as a competitor of yours in this, give guidance through the middle of 2020, and are expecting softness to remain in demand through mid 2020, do you can concur with that outlook, and do you need to take further cost actions in response to that demand outlook?

Yes, I would say that's pretty much in line with what we are seeing. There is no question. I mean, there is softening taking place, and I think it's a prudent assumption to assume that it will occur probably in Q1 and in Q2 as well. Nevertheless, as I indicated earlier on, we still believe there's going to be a soft landing and we'll see some positive signs for the latter half of 2020.

Does that soft landing assumption mean that you're not going to take much more in the way of cost out of the business at this point?

Well, I mean we took some action relatively early as you saw with some of the restructuring that has taken place that with the early retirement program. Nevertheless, we want to be cognizant and we have identified other areas. So I think, if matters could fast and more than anticipated, we could tap into some of the other opportunities that we have identified already at this stage. Having said all that, we also want to be careful. And obviously, as I pointed out and prepare for the upswing already because we know the industrial businesses turn very fast and it's the very preface I think of the turn where we can gain market share. So we also want to make sure that we maintain the structure in place that we can take advantage of such a term to be expected in the latter-half of 2020 or no later than 2021.

Thanks very much for the color. I will pass it on.

You are welcome, Nathan.

Thank you. Next question is from the line of Jeff Hammond from KeyBanc Capital Markets. Please go ahead.

Hi, good morning.

Good morning.

Good morning.

So, it looks like fourth quarter implies a pretty sharp drop off despite some of the backlog resiliency in Hydraulics and I think pretty high decrementals if I'm doing the math correct. Just as you -- yes as you adjust your cost structure, how quickly can you kind of normalize that decremental pressure?

Yes. The decrementals that you see in Q4, do you have some seasonality based into them, so we would not expect to see that level of downside in 2020, as we roll into Q1. We would expect to see those decrementals more normalized 40-ish kind of percent. I think if you do the calculation, we're at about 60% in Q4, but again that's related more to seasonality.

Okay. And then Electronics, it sounds like you were talking about sales cycles are ramping slower and I think you were originally talking about kind of a snap back in growth as you adjust away from that one customer more broad customers, but how are you thinking about kind of that ramp in the growth rate into 2020 as that dynamic plays out?

I mean first of all there, I think we are progressing right now, we expecting as we had anticipated, probably during the course of Q2 and also in Q1 when we basically make the decision to tackle the dissolution of these contractual obligations that we had in place and I pointed out, I mean we are in very intense contact with the number of customers in different geographies that would basically by these products and services down the road. Now, obviously at the end markets soften the ramp-up, could be a little bit slower than originally anticipated, but we are very hopeful. I think at least for 2021 and beyond that, because we see very positive signs on the horizon. Not just for basically these products and services that, these results from the dissolution of the contractual obligations, but also the other activities that we have ongoing with OEMs, indicate pretty strong tailwind. I would say for 2021, if we look at the projected S&P.

And the out years too and mean we have activities going on already for 2022 and 2023.

Okay, great. And then maybe just given the order softness, can you comment on October and then just on acquisition pipeline certainly recessions create opportunities and just what's your kind of management capacity to start looking at external growth, again, as we kind of move away from the faster and CFP integrations?

With regards, to the first point, I mean, in October, we saw what we expected to see. So, no surprises at all, I think, order rates were in line with what we expected at the end of the Q3 already. With regard to the second question, with regard of acquisitions, that's a completely separate process as I always pointed out, so we continue doing our homework independent, where we are in the economic side. So, we are not overly-opportunistic here that we want to make an acquisition in a downturn, because we believe the multiples are lower. First of all, we only acquire, first-class company, so obviously they are not necessarily forced to sell during down cycle, right. They could wait and write it out, but the process is ongoing, we are slicing and dicing the different technology fields, because obviously we want to be here for the right point in time, down the road.

Okay. Thanks a lot.

Welcome.

Thank you. The next question is from the line of Brian Drab from William Blair. Please go ahead.

Hi, good morning. Thanks for taking my questions.

Sure, Brian.

Hi, good morning. Thanks for taking my questions. What is the capacity utilization right now in the CVT business?

Well, it depends on the area that you are looking for, Brian, as I pointed out for the large volume the series type of product families. We have probably a utilization of about 42% to 50% and then we have capacity constraints in all the other area we are still ramping up capacity in those areas. But to answer this question is also depends on basically the shift models that you apply and it's relatively difficult obviously to deploying third shift coverage, if you look at the constraints we have with the labor market. So this is a pretty complicated question but from a high level perspective, to give you an accurate answer, I would say it's about 40% in the higher volume type of product families and it's pretty much at capacity in the lower ball. I would refer to that the one that type of stuff.

Okay. And the 40% to 50% in the large volume contemplates but 100% would be a three-shift model a two-shift model or could you just clarify that?

It would be a two-shift model and then with the possibility to expanded even two-and-a-half or three shifts. And this type of the business, Brian, as I said is more tied to classical OEM business. Soon OEMs are picking up, we would expect to see better utilization of installed capacity entities.

Okay, got it. And then in the electronics business, one of the issues has been that you're going between some customer platform rollout. Can you talk in a little more detail regarding your what visibility you have 2020 and some of those platform rollouts and could that drive growth in electronics in 2020 despite a continuing challenging environment, at least in the first-half of the year?

Yes, so as you know, Brian, so our business in electronics is about 50% OEM-driven, 50% channel-driven, roughly. So, obviously with the OEMs, we have more visibility, we have visibility already into 2020. I can happily think here that if we look at all the anticipated product launch in 2020 that they are still scheduled. There is no push out. However, as I always point out that this location. Obviously, the ramp-up curve could be slower, so there could be lower volumes during the ramp-up, but all the originally scheduled product launches for 2020 years still in place.

And is there any way to quantify, how many product launches in 2020 versus 2019, just so we get a sense for, how much of a tailwind that could be.

We would always say, it's pretty much around launches. Now the magnitude of individual launches can differ from year-to-year, but do you to give you a ballpark number, you can see that we'll be probably around about 10 product launches also in 2020.

Versus how many in 2019?

Pretty much the same, it's pretty much the same number, this varies between eight and 12 certain times may be a little bit higher, but around 10 is a good number and we will launch new products irrespective. I mean, what the economy will do the only variable is the volume in the ramp-up of the launch it.

Yes, and that's dependent on the OEM and the specific of vehicle that those are going onto.

Okay. So just to summarize, it's really to make sure I understand, it's not really the number of model year rollout, it's the size and magnitude of some of these model, your rollouts that are the smaller this year?

Yes.

Okay. I'll pass it on. Thank you very much.

Thank you.

Thank you. The next question is from the line of Joe Mondillo from Sidoti & Company. Please go ahead.

Good morning, everyone.

Good morning, Joe.

Good morning, Joe.

Just in terms of the CVT capacity issues that you had is that you were dealing with running up against capacity and not having enough capacity, four, five quarters ago and you did a lot to sort of reorganize the operations down there. I'm just curious, how was then a positive or a negative as we go into sort of a lower volume time period was your cost structure expanded by doing what you did in trying to improve capacity. I know a lot of it was re-org organizing and just improving efficiencies to try to open up that capacity, but I'm just curious, going from a time period, where you didn't have enough capacity, and you were trying to expand capacity to now, we're seeing lower volumes, how that sort of change your cost structure?

Yes, I think from a cost structure perspective. This has no impact, if you go back and if might and if I may, refresh your memory here, first of all, this was an [indiscernible] do install additional capacity because we have been seen successes in the marketplace that converted into orders at the end of the day. So, once the economy turn back and I think it was the third quarter of 2016 -- September 2016 at the recall, when we saw the first uptick in orders, we were probably around 10% below capacity full capacity and that is, and then we started to ramp up capacity immediately. So, this has been a consistent effort actually going back since fourth quarter of 2016, if you look at absolute numbers, and I don't want to give you specific numbers, but I can give you kind of percentages here what we wanted to accomplish also in alignment with vision 2025, for that type of the business. Our claim back in 2015 was to quadruple the business by 2025. And that would require that at the beginning of 2020, you are again of 2019 to have a capacity installed that is about twice the capacity of 2015. And we are right on target to accomplishing that, if you look at the installed capacity. We have already now or will have by the end of this year, it's about twice the capacity, we had five years ago. So we are in line with that. Now, you have to deal, of course, with product mix and economic cycles. And as I pointed out before, Joe, we wanted to get ahead of the curve here, so that when the next upswing comes that we really can take market share. But if you go back and look at fourth quarter 2016, you look at all of 2017, in all of 2018 and now the first three quarters of 2019, then, you will see that our hydraulics business has clearly outpaced revenue growth of the peer group. Nevertheless, I'm always saying that criticized our self. We could have done even more, if we had the capacity in place back in 2016 and 2017. So in order to get ahead of the curve, that's why we are doing it, I don't want to get caught up in the same situation again as we were the last two years of not having enough idle capacity available, but we will fill it down the road in the context of Vision 2025 that would quadruple the sales volume of 2015.

I would add that from a cost structure perspective, what you're seeing now in some of the margin pressures is related to the fact that we aren't fully utilizing the capacity on the high volume product line and assembly line. So once we're able to fully utilize that in conjunction with being at near full capacity on the lower volume of product use. So, I think we'll get tremendous leverage on the fixed cost of that business.

Okay, great. Thanks, I appreciate that. Also I wanted to ask about SG&A costs, at the run rates that we saw in the third quarter have, are you doing things to restructure that going into the fourth quarter or were things sort of mainly in place at the beginning of the third quarter knowing seeing the headwinds and seeing the way the markets we're shifting?

Yes, so the restructuring that we did really, didn't have a large impact other than the 1.7 million in costs on Q3 we won't start to see the benefits of that in for Q4, we do expect to see about $600,000 in total savings in about 25% of that is related to FDA and when you look at the numbers that we put out for cost savings of $3 million to $3.5 million for 2020, about 1/3 of that is FDA for 2020.

Okay. And then just going back to the electronics business, I'm not sure, if I sort of missed a little bit of your prepared commentary, but I'm just excluding sort of these purposeful reduction in certain customer platform, so you can expand your opportunities. Excluding that, what is sort of the true growth that you've been seeing in electronic?

I think if I understand your question correct there, I mean, if you look at the decline, you can pretty much say half of it is economy, half of it is the evolution of the contractual obligation.

Okay. And the status of those end markets in that business, specifically on your sort of non-core recreational, and are you seeing further deterioration in those markets, or has things been sort of stable for the last few months, or how would you characterize those recreational end markets?

I think that probably is a little bit soften, but those markets are not that bad, but things have definitely softened a bit more over the last two quarters.

Okay. Okay, I think that's all. That wraps it up for me. Thanks a lot.

You are welcome, Joe.

Thank you. The next question is from the line of Jon Braatz from Kansas City Capital. Please go ahead.

Good morning, Wolfgang, Tricia.

Good morning, Jon.

Good morning, Jon.

Wolfgang, I've been listening to a number of conference call over the past week and a half. I guess my question is did you see a significant acceleration of order rates in late August, early September. Did you see some significant weakness late in the quarter as opposed to, what you may have seen earlier in the quarter?

Yes, I think that's a valid statement, Jon, I think if I break down the third quarter and look at the individual months, I think quite significant weakness set in September, but last of the quarter. So, your statement is true.

Okay. Did you see that how pervasive across your customer base, you're -- how pervasive was that, was that across all the markets?

Yes, as I pointed out earlier on, Jon, we had seen that across all the eight markets, maybe only with the only disclaimer, I would put on; we've seen it with a little bit more severity in Europe, from a geographical perspective. And then we had some exceptions, as I pointed out, if I look at renewable energy in China that has remained reasonably solid, but other than that we have seen it across the board and probably a little bit more severe in Europe than in other geographies.

Okay. Second question, you called out the oil and gas market for a little causing a little bit of weakness in the Electronics segment. And do you had some exposure there, but how significant exposure do you have the oil and gas market?

I think, if you will, not look at all of Helios, we have about 8% of revenue.

I'm sorry. I didn't hear that, Wolfgang.

Roughly 8% of revenue, of all of Helios is tied to the oil and gas market.

Electronics specifically is probably closer to 15…

Little bit higher, yes, Electronics itself is a bit higher, but across the company, it's about 8%. We didn't have last year, were the numbers, and I don't think they've changed a lot.

Okay. All right, thank you very much.

You are welcome, Jon.

Thank you.

Thank you very much. The next question is from the line of Josh Pokrzywinski from Morgan Stanley. Please go ahead.

Hi, good morning, Wolfgang, and good morning, Tricia.

Good morning, Josh.

Good morning, Josh.

A question, I'm not sure if you touched on this directly or not, if you could view of kind of bounced on the edges of it. Wolfgang, can you just tell us either what book-to-bill was in the quarter or how much backlog is down, because -- this whole element of, like how long this backlog really stretched to you is a little tougher to calibrate?

Yes. So I mean it's obviously, if you can fence based on the statements we have been making it depleted quite a bit in the third quarter, but I just reiterate what I said earlier on, will still tap to that in Q4 and Q1. It still depends a little bit on the order intake that we expect. So obviously we have been a little bit cautious here, but overall we are still expecting softening to continue in Q4 in the first-half of 2020. So we are depleting the backlog, but there is still backlog left, I would say for the next -- I feel comfortable seeing possibilities to tap into good backlog for the next two quarters.

Okay. And then, just as you talked about and you're kind of preparing for the next up cycle and I can understand being sensitive to being caught short on capacity as what happened in 2015-2016, but if I'm reading your commentary right, not really expecting markets to turn until maybe second-half of next year. What is it you're doing kind of nine, maybe, 12 months ahead of an expansion that would kind of be necessary that far out in terms of preparedness? What does that exactly look like, either from a capacity perspective, you know, a channel perspective, new products and maybe just kind of go down the list of what that nine or 12-month preparedness would entail?

Yes, very good question, I mean as I pointed out earlier on, obviously the focus is got to be on cash flow here, obviously working capital, cash flow and profitability. So I think if you go through this type of interim period between cycles, I think this is all about focusing on cash flow and preparing for the upswing. I pointed out earlier on, Josh, we still have identified areas, if the softening would deteriorate then we can tap into those as well. So I think I would describe this time now as striking the right balance between protecting bottom line, optimizing cash flow, and at the same time, preparing for the upswing and being ready.

Yes, I guess just specifically on that upswing side, is it -- it doesn't sound like you're building inventory, but what exactly does that -- what it does that involve kind of farther in advance. I can understand you're managing the downturn that totally makes sense, but just, I'm having a harder time conceptualizing the, you know, way you're preparing for the upswing right now.

I think as far as the upswing is concerned, that means at the end of the day for the front end of the business, I mean, sales and marketing, to be even more active than during the boom times, because now is the time when our customers have time to listen to us for new technical solution, where we can discuss the next generation of machine design. So our sales force is expected to be extremely active. So they got to be on their toes all the time because now customers around the world have time to sit down with us and discuss new innovative technical solution.

In our businesses that are more OEM-focused, we're already sitting at the table from an R&D perspective and looking at what products are going to be needed going forward. So I think we're in a good position at this point with those projects that are already underway for the -- when the economy turns around and those -- can turn into products that are sellable.

Got it, that's helpful, and then just lastly on some of the contract changes, customer changes that you did in the Electronics side, is there any scope to kind of re-evaluate what you do in hydraulics either from a customer perspective, distribution, I think you have a much more kind of technical distribution base, is there any interest in perhaps broadening that just kind of speak to maybe any opportunity of buying that same logic from Electronics into the Hydraulics?

Yes, I mean we are still trying to basically spread our wings in geographies where we have little or no coverage. So we are still finding on channel partners in certain parts of Southeast Asia for example. So that's a good example. So adding channel partners and getting better coverage of the global marketplace is something that we continue to do on an ongoing basis.

And with regard to our synergy projects, I think, we're doing a good job of identifying, how we can cross-sell between the channels within each of the companies as well that are bringing new opportunities.

Thanks, that's helpful. I'll leave it there.

Thank you.

Thank you very much. [Operator Instructions]

It looks like the time is up. We are ready to end the call. So I'll ask Wolfgang to provide his closing comment.

Sure. Thank you for your interest in Helios Technologies and for your participation this morning. Also thanks to all of the hard-working Helios employees who were driving these results. We look forward to updating all of you on our first quarter and full-year 2019 results in February. Thanks again. Thanks a lot, and have a great day.

Thank you very much members of management. Participants, this concludes today's conference call. And you may disconnect your lines at this time. Thank you for your participation.